Volatility and Low Yield Drive Investor Sentiment02.24.2014
Volatility and the current low-yield environment are among the main drivers of sentiment among high-net worth individuals and families, according to Jennifer Hartmann, partner and Financial Advisor at Morgan Stanley’s Pelican Bay Group.
“Volatility is of concern to clients,” said Hartmann. “As the year opened with volatile markets the VIX spiked in early January. Volatility was added to client concerns from a low yield environment. Many are likely frustrated with low fixed income returns and the outlook for that asset class.” Some investors may be shifting assets out of fixed income into absolute return strategies, she added.
Pelican Bay Group, which manages about $2 billion in assets (as of December 31, 2013), is known for its use of covered calls, by which it writes call options on the positions in its portfolios.
“We work with 400 other financial advisors at Morgan Stanley to manage portfolios that include covered call writing,” Hartmann said. “We use blue chip stocks and actively manage our short call positions. Generally, we write call options with a life expectancy of 30 to 60 days. We utilize a combination of qualitative and quantitative analysis on the stocks we select, and similar analysis on the options we write. We are looking for high quality stocks that clients are willing to own as part of their allocation, and by writing calls we have the potential to generate additional levels of cash flow to compliment equity dividends.”
Covered call writing is heavily influenced by volatility: The higher the volatility, the greater the option premium, all things being equal. However, the flip side is that with higher volatility, managers need to be more active in follow-up tactics in order to manage short calls. In return for the premium received, the call writer agrees to sell the stock at the strike price if the option is assigned. In effect this caps the upside potential of the stock.
“Volatility is a major factor in the option strike decision, such as how far we might write out of the money,” said Hartmann. “It’s also a factor in how active we might be willing to write; if we’re writing closer to the money and we’re getting volatility, we might write a little farther out, and perhaps take in less income as a trade-off to seek more upside on the stock.”
In addition to the assets Pelican Bay Group manages on a discretionary basis, which accounts for about three-quarter of its total assets under management, the Group “uses products, services, and other managers on which Morgan Stanley performs due diligence” Hartmann said. “We access Morgan Stanley’s Consulting Group and Advisory Platform, and search and select from those programs.”
For investors who can withstand short-term portfolio volatility, high yield bonds may offer distinct benefits.
“High yield bonds may be more vulnerable to credit risk, but we believe some exposure to high yield investments may be beneficial to investors, particularly during this low yield environment – if you are investing with an experienced management team,” said Ashi Parikh, CEO & CIO of RidgeWorth Investments.
High yield bonds tend to have less sensitivity to price declines than their higher quality counterparts during periods of rising interest rates, providing the potential for added security in a changing rate environment, according to a report by Ridgeworth Investments.
“Of course, by definition, these bonds are riskier than their fixed income counterparts. Professional managers are continually evaluating the market and making portfolio adjustments to help investors minimize that downside risk,” Parikh said.
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